Sunday, July 31, 2016

Physicians are taught that diagnosis precedes treatment: you have to identify and understand a problem before you prescribe medications or initiate procedures. Many symptoms can have multiple underlying causes. Is an abdominal pain related to an ulcer, might it reflect an inflammatory bowel condition, or might it be an early sign of appendicitis? Location matters. Type of pain matters. Timing of the pain matters. Before you initiate treatment, you gather information: a history and physical, blood tests, imaging studies. Only after thorough evaluation do you intervene. That is because treatments themselves carry risks. Physicians know that their job is to "above all else, do no harm." If you don't understand a problem, don't begin surgery; don't prescribe a medication with side effects.

The process of evaluating and gathering information before taking action is very relevant for traders. When we act as our own trading coaches, in a sense we act as our own physicians. If our trading results are not so healthy, our task is to understand why, so that we can initiate the right corrective measures. To change our trading when we don't truly understand the problems we're facing is to run the risk of doing further harm. Alterations of our trading can bring side effects and complications as well as solutions.

So how can we accurately diagnose the problems that we encounter in running a trading business? I propose that the great majority of trading problems fall into one of three categories. Knowing which category is relevant to your problem is an important step in identifying potential solutions.

1) The trading problem is a business problem - A while back, a trader reported to me that his trading was not making the kind of money that he had hoped. We examined his performance statistics and it indeed seemed as though he was making money. His hit rate on trades was favorable and he was making more money on winning trades than losing ones. His Sharpe ratio--the amount of money he was making per unit of risk taken--was solid. So what was the issue? Quite simply, he had a small trading account. He could not make significant money because he started from a small capital base. If he leveraged his account too much, his drawdowns would eventually place him in a risk-of-ruin situation even though his overall trading was sound. What he needed was greater access to capital. The answer wasn't a psychological technique; nor was the answer to change his trading. The answer was to gain greater access to capital. I helped him identify a proprietary trading firm that fronted his trading and he found far greater monetary success. This was a business problem, pure and simple. A different trader was struggling because he was following too many markets and tracking too much information. Our evaluation found that tracking all this information did help his trading. What the trader needed was an assistant to help him sift through information. His trading had grown to the point where he needed to build out a team. That's a business problem, requiring a business plan and a new business direction.2) The trading problem is truly a trading problem - One of the best diagnostic processes for any trader is to take an inventory of winning and losing trades and identify potential patterns of strength and weakness. A trader I met with conducted such an assessment and found that he consistently lost money in low volatility, rangebound markets. This was because he was trading momentum patterns. His problem was that he lacked reliable and valid tools for identifying market regimes. Once he developed a couple of screening tools, he could then focus on only those markets that were trading with higher volume and volatility and ignore the ones that were slow. He also learned to pull back from trading when markets overall were slow and to take proper risk when his reliable breakout patterns were triggered. His trading problem was creating frustration and discouragement, but it would have been a mistake to focus on emotions alone. He needed to better identify and adapt to changing market conditions. No amount of psychological, self-help methods could have solved his problem.3) The trading problem reflects a psychological problem - Sometimes the patterns of winning and losing trades have less to do with market conditions than with the condition of the trader. One trader I knew had trouble accepting losses and became angry and frustrated after drawdowns. This led to classic revenge trading to make the money back. Of course, such reactive trades only further served to deepen the losses and increase the frustration. The underlying problem was that the trader could not emotionally distinguish between losing on trades and being a loser. He viewed losses as failures and took those personally. Other times, traders may find themselves making poor decisions out of boredom or overconfidence. The answer to these situations is to recognize one's "triggers"--the situations that set off the poor trading--so that those can be processed in a different fashion. The trader who became angry when losing engaged in ongoing visualization exercises where he rehearsed a different kind of self-talk during drawdowns. Eventually he internalized this new self-talk and was able to not take losses so personally and even learn from them.Too often traders fiddle with their trading and make large changes in their risk taking without properly going through a self-evaluation. Successful traders spend as much time studying themselves and their trading as studying markets. In the patterns of your best and worst trades is the information that can make you the best trader you can be.Further Reading: Evaluating Yourself as a Trader
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Saturday, July 30, 2016

A little while ago, I wrote on the topic of three questions to ask about any market. That post became far and away the most popular post in TraderFeed's 10+ years online. That was followed by a post on three questions to ask about your trading. All too often, we turn to psychology for answers when the stark reality is that our distress and frustration are caused by poor trading practices. In this final post in the series, we'll take a look at three questions to ask about yourself and your capacity for peak performance. How we manage life outside of trading plays a central role in how we perform as traders. Think of it this way: all of life is practice for performance. Our approaches to life's challenges inevitably shape our approaches to the challenges of markets. How we handle risk and opportunity in life impact our handling of losses and gains in markets--and the reverse is true. Successful people build successful habit patterns, which means that personal life and performance become mutually reinforcing.With that in mind, here are three questions to ask about your trading psychology:1) Am I living a goal-focused life? - There is no extraordinary achievement of a lifetime that does not result from a succession of extraordinarily productive and successive days. Big achievements are the culmination of small, daily achievements. Getting through day by day cannot lead to standout performance month by month. Successful people push the envelope on a daily and weekly basis, expanding their comfort zones. That fuels sustained effort over longer time periods. The goal-focused life is a life based on learning, growing, and developing. Both stasis and effort can become habit patterns. Immersion in routine is a great formula for routine performance. Greatness lies just beyond routine, beyond our comfort zones. Small wins--the achievement of small goals--fuels the internal sense of winning, and that fuels much larger wins.2) Am I leading a meaningful and fulfilling life? - Two of the most important dimensions of emotional well-being are happiness (doing things that bring joy to your life) and satisfaction (doing things that are meaningful and deeply rewarding). When we experience meaning and fulfillment outside of trading, we are best able to weather the ups and down of profits and losses. We're also most likely to be in an energized psychological state that fuels our focus and persistence toward goals. When we lack meaning and fulfillment outside of markets, losses on trades begin to feel like losing in life. That can be extraordinarily disruptive. When we lack well-being in the rest of life, too often we try to manufacture it in trading. That leads to overtrading, where we place our capital at risk more for psychological reasons than logical ones. Look at your relationships; look at your activities and interests outside of markets. If you would lack a full life if you could not trade, you will be vulnerable in your trading.3) Am I leading an energized life? - We are physical beings, not just psychological ones. The state of our mind is intimately connected to our physical state. If our bodies are tense or drained, we will find it difficult to be calm and focused. Meditation and yoga are methods of using physical activity and breath control to achieve new cognitive and emotional states. Aerobic exercise yields significant gains in emotional well being and stress management. When we are physically energized, we are most likely to be inquisitive, creative, and willing to push our envelopes. When we are operating on a partial battery charge, we get through daily activities and never move beyond the routine. Note that one way to lead an energized life is to lead a meaningful one, making the most of your spiritual beliefs, values, and relationships. All of life, from how we eat and sleep to how we spend our free time and who we spend time with, either gives energy or drains it. Successful people are remarkably successful and staying plugged in and recharged in all areas of life.A good start for working on your trading psychology would be to keep a personal scorecard that looks at these three areas daily: Am I goal-focused? Am I doing things that are meaningful? Am I staying energized? We can write in journals all day long. Unless we're actually working on the areas in life that are significant, we're unlikely to make and sustain positive changes in life--and in performance.Further Reading: The Mia Principle
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Sunday, July 24, 2016

Gut feel without understanding leads to the trading of randomness.Backtesting without understanding leads to the trading of randomness.Nothing substitutes for a reasoned understanding of how markets behave and a disciplined execution of trades that reflect that understanding.I hope this post points the way to your shining success as a trader or at least convinces you to pursue your shining success elsewhere.Brett

Saturday, July 23, 2016

I recently wrote the post on three questions to ask about any market. That has turned out to be the most popular post to TraderFeed ever, which says something given 10+ years of the blog's existence. My sense is that people recognize that there is much more to understanding markets than trading off the latest headlines or chart patterns. The "three questions" post is an attempt to distill markets to their essence and provide a framework for thinking the meaning of market behavior.Similarly, people recognize that there is much more to trading psychology than keeping their heads on straight. The three questions to ask about any market follow from a core recognition: that markets represent auction processes. Once you focus on market behavior as the result of bidding and offering in a real time auction process, you can ask those three relevant questions.The three questions to ask about your trading also follow from a core recognition: trading is a creative process. Just as an entrepreneur succeeds by creating new goods and services or by delivering goods and services in new ways, the trader succeeds by discovering and exploiting fresh opportunity. Show me a trader who has made money consistently and I'll show you someone who displays uniqueness in their viewing and doing. Once you recognize trading as a fundamentally creative, entrepreneurial activity, the questions to ask about your trading follow naturally:1) Am I looking at new information in new ways? - You don't mine for gold where everyone has been searching or, if you do, you use new tools that help you dig deeper and sift better. A wise portfolio manager recently explained his success by citing the importance of exploiting "hard to get data". That's where the truly new information--and the possible future sources of edge--lie. For example, in a recently developed routine, I break the day's action in ES into bars that represent a given number of trades. It's quite common for a single day to break down into 500-1000 bars, depending upon the level of market activity. I then look at the volatility of each bar and the degree to which expansions of volatility result in directional price movement. It turns out that expansions of microvolatility that have a directional bias precede short-term market trends. The new information is capturing the behavior of large market players who have to enter their positions over time because of their size. If you can recognize this process early, you can ride their waves. New information leads to new, promising trading.2) Am I synthesizing market information, not just analyzing it? - Analysis gives us the pieces of the puzzle, but it's a perceptual synthesis that helps us identify what the puzzle represents. Without that synthesis, we can't assemble the puzzle; it makes no sense to us. Synthesis is sense-making; it's taking information from multiple sources and assembling it into a coherent market picture. Perhaps we see a possible trend starting per the discussion of microvolatility above. At the same time, we notice that one sector of the market is breaking out to the upside and other risk assets are firming, despite a seemingly bearish data release earlier in the session. Putting those pieces together, we recognize that the path of least resistance is to the upside and we construct a solid risk/reward entry. Too often we get lost in the weeds and overreact to single pieces of data. Our noses are so stuck in the screens that we don't pull back to see the broader context of what's going on in markets. Successful traders operate with microscopes and telescopes, developing ideas that synthesize the here-and-now with larger market patterns.

3) Do I flexibly adapt my trading style? - Traders often insist that they succeed by finding a trading style that fits their personality and faithfully sticking to that style. I've come to recognize the limitations of this view. A while ago I gave the example of the radio station owner who played music he believed to be "good music". The problem was that musical tastes were changing and people did not want to listen to the music he believed to be good. Rather than adapt to consumer needs, he stuck with his style and drove the business into the ground. Creativity means that we flexibly adapt to changing conditions. We don't insist that markets follow our predilections. When I adopted cycles as my unit of market analysis, issues of "trend trading" vs. "mean reversion trading" became moot. At certain, early portions of a cycle, you trade the momentum. At other points, you fade directional moves. When cycles are higher frequency, you trade in and out more opportunistically. When lower frequency cycles dominate, you can behave more like an investor. The market plays the music. How you dance depends on the music being played.

Too many traders approach their craft as if they're managing a manufacturing process. They don't recognize that they are also managing a creative enterprise. How you manage an assembly line making widgets is different from how you manage a movie studio. It's great to become more consistent by introducing process control and staying process driven--but not if the rigidity of process becomes a straitjacket that limits the creative essence of managing our capital.

Sunday, July 17, 2016

There's a lot to be said for wandering. Pick a promising area, wander about, and you can discover quite a bit. Discovery is all about open eyes and open minds. Here's how I've been wandering through markets lately:Speaking with trading and investment professionals, particularly in the quant world, I've been struck by the fact that the models they employ to guide their decisions are not the kind of models we typically read about in trading texts. There are no technical indicators or chart patterns in their inputs. Nor are there any inputs pertaining to company earnings, economic growth, upcoming central bank meetings, or geopolitical events. Rather, returns from markets are broken down into basic "factors", such as momentum/trend, volatility, value, and carry, with models designed to capture these factor-generated returns. A discretionary trader might justify trading a trend following method or a mean-reversion/reversal method based on his or her "personality". This is nonsensical to the money managers I speak with. It's like saying that I'm right handed, so I'll only take right turns in my car. If returns come from a variety of factors, the best performance can be achieved by trading signals derived from each of these factors. This will diversify returns and produce better risk-adjusted results.A comparison of returns from quant asset managers vs. discretionary trading firms finds that returns indeed have been better from the former group. That is not simply because these funds are quantitative--I can think of quant funds that have lost money lately. Instead, the superior performance comes from generating returns from multiple factors across multiple time frames. Many good models producing independent, positive returns--not necessarily eye-popping ones--can combine to form a robust P/L stream.So I began my wandering. Of all the market data sets I track, I identified the ones that: a) produced the most reliable and valid trading signals; and b) had very low correlation to one another. A total of six variables popped up. To my surprise, one was based upon volatility; two were derived from cycle-based forecasting methods; two were based on momentum (trend); and one was based upon value (mean-reversion). I built six simple forecasting models based on the six variables and then combined the model outputs into a single "committee of experts" signal. (See this article for an overview of creating ensembles of forecasting models).I was surprised by the degree to which the trading signal from combining the individual forecasting models handily beat any of the individual models. Still more surprising from my perspective was that the combined trading model seemed to "know" when to trade like a trend trader, when to trade like a reversal trader, and when to make money from shifts in volatility. The model seemed to work by navigating the ebb and flow of factors. Most surprising of all, however, was that when I trained the models to forecast shorter-term price change, certain forecasting models dropped out, some received extra weighting, and some less. This raised the possibility of using shorter-term models in a Bayesian fashion to navigate longer-term signals. That is, you would use short-term forecasts and returns to change your assessment of the odds of a longer-term forecasted move playing out.I'm not at all convinced that this means we should all toss our experience aside and become programmers, statisticians, and systematic traders. Could it be that the discretionary "tape-reading" skill of the short-term trader can help navigate shorter-term forecasts, just as those shorter-term forecasts can help us participate in longer-term forecasts? In other words, such trading would be neither wholly discretionary nor wholly systematic. It would be discretion--with road maps.But isn't that the way we travel when we drive cross country? We don't simply rely on feel and intuition; we look at maps and we rely on GPS signals. On the short time frame, however, we *do* use our feel to navigate lane changes, select optimal places to stop and rest, and adjust our speeds to road conditions. The skilled driver has experience and road feel--and maps and GPS signals from trusted data sources. Perhaps the skilled trader is not so different, navigating moment to moment price action, even while benefiting from the road maps of forecasting models.Further Reading: Factors and Short-Term Market Returns
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Saturday, July 16, 2016

A problem with much of the theory and practice of trading psychology is that it is grounded on the experience (and issues) of retail traders and relative newcomers to markets. I suppose that's inevitable, as a sizable proportion of writers and practitioners have not actively traded themselves and many have not routinely worked with trading and investment professionals. A result of this limitation is that much of trading psychology focuses on such issues as controlling one's emotions and following a defined process. Those are important issues to be sure. But limiting trading psychology to those is like limiting the coaching of baseball to holding a bat properly and getting in front of ground balls before fielding them. Great stuff for the noobs, but not exactly what the experienced, successful folks are working on.

Here are a few areas of trading psychology that I find to be of much more relevance to traders well along their developmental paths:

1) The cognitive side of trading - How do you process information most efficiently/effectively and how can you refine your market preparation to better leverage your information processing strengths?

2) The epistemological side of trading - How can you most effectively integrate quantitative data on markets (predictive models) with an experienced feel for markets? How can you best blend analysis and intuition?

3) The tactical and strategic sides of trading - How can you quickly identify when markets are changing and adapt to those changes? How can you stay true to how you trade without becoming so inflexible that you become a dinosaur when markets evolve?

4) The personal side of trading - How can you best manage your personal life and maximize your experience outside of trading so that you are best able to maximize your focus and energy while you are trading?

I find that difficult periods of trading offer the greatest opportunities to work on these areas. Most of the time, trading is difficult because we have not sustained that ABCD focus. Somewhere in the cognitive, epistemological, tactical/strategic, and personal sides of trading, we're not making the most of our strengths. That becomes our path for development. The expert sailor has learned from stormy seas: skill development is one of the most powerful paths to psychological development.Further Reading: The Single Most Important Trait of Successful Traders
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Sunday, July 10, 2016

The answers we find in markets are dependent upon the questions we ask. Here are three important questions to ask each trading day:1) Who is in the market? - If I want to play poker at the casino, I'll watch the tables for a while. I want to get a sense for who is playing, because that will help determine if I play and how I'll play. If I want to play in a chess tournament, I'll study the past games of my opponents and calibrate my play accordingly. If I draw a team as a first round opponent in the NCAA basketball tournament, I'll want to watch film of that team and figure out how to set my offense and defense. It's no different in markets. We want to figure out who is trading, who we can potentially profit from. I trade the ES futures. For each half hour of the day, I know the expectable volume and the average variability around that level. I know that we can usually expect twice as much volume at the 10 AM period as at the 11:30 AM period, but with only a third more variability. What qualifies as high and low volume at one period is different from another. When we get meaningfully above average volume, I know to expect more directional market activity; when the market is well below average in volume, I know to expect a market dominated by market makers, not directional participants. Knowing a piece of news, a chart pattern, or statistical study is only helpful if there are participants who will act on that information.2) What are they doing? - If we're seeing strong market participation, we now want to see if that participation is skewed toward buying or selling, or whether buying and selling are relatively balanced. I follow the data for upticks and downticks during the session ($TICK for NYSE shares; $TICK-US for all listed shares via e-Signal) to tell me whether buyers or sellers are dominant across the broad range of stocks. Values above +800 and below -800 are statistically significant, suggesting broad buying or selling at that moment. When we see persistent, elevated TICK readings, we know that participants are strongly leaning one way. At important market turns, we can see a drying up of those readings and, often, more balanced readings. Whether we trade or fade buying/selling depends upon whether participation is increasing (who is in the market) and whether the skew of their participation (what they are doing) are expanding or contracting.3) At what prices are they doing it? - If we see volume and buying pick up, it's worth noting the price levels at which that is occurring. Should the volume and buying dry subsequently dry up, all those buyers are going to be vulnerable, especially should price return to their levels of entry. Very often we can see where buyers or sellers will be trapped by reversing markets by observing the price levels at which volume has expanded and the degree to which there was skewed buying/selling at those levels. Many, many market participants are overleveraged and can't take heat. They have to flee their positions if they start going against them. If you can gauge where their positions lie, you have a good chance of benefiting from their vulnerability.

The answers to these three questions help me understand what is going on in markets. I'm not interested in making market predictions in the absence of such understanding. Many times, those answers will not be clear. Volume and the breakdown of volume by buyers and sellers will not vary greatly from average. There won't be much edge. As any poker players knows, that information is valuable. Knowing when to not play is just as important as knowing when to bet large.

Markets are auction processes. Who is at the auction, the nature of their involvement, and the prices at which they're willing to transact all provide useful information to the participant. If I'm at the cattle auction and dozens of ranchers are looking to acquire steers and only a small number are up for auction, my strategy will be quite different than if only a few ranchers are present and a greater number of steers are available. No one at the cattle auction draws shapes on charts to figure out what to do, and no one at the cattle auction frets about the latest pieces of economic data or the pronouncements of central bank officials. If you understand the auction, you know how to participate, whether it's a stock auction or a livestock one.

Saturday, July 09, 2016

Friday was an interesting day for me in the market. It captured a lot of what I've been doing right as a trader and a lot of what I still need to accomplish. As I shared with several colleagues, my cycle work has been looking toppy. During the recent market strength, sector participation has been uneven. Yield-sensitive shares have rocketed to new highs, while many others have lagged. Banking shares, in particular, have looked weak. All of that meant that I went into the day leaning to the short side. Given an important jobs number coming out, however, I took no position into the event. The number was uber-strong, the market rocketed higher, and trended higher for most the session.In the past, I would have traded my bearish view, hit my stop, and taken my loss. In my recent trading, I don't take a trade unless everything lines up. The tape action contradicted my cycle view and I stood aside before the number--and after the number. I never traded. I finished the week at my high water mark for the year. By trading super-selectively, I've sustained a high hit rate and a high Sharpe ratio. The average daily volatility of my P/L, however, is quite low. By waiting for everything to line up, I'm making money when I play and I'm not playing all that much.Early in the day on Friday, after the release of the number, I said to myself that we have a potential trend day in play. Buying early weakness was a good trade, albeit not the great trade that I've looked for in waiting for everything to line up. By not taking good trades and only taking the great ones, I've been maximizing my risk-adjusted returns (how much I make per unit of risk taken), but leaving a lot of absolute returns on the table.Friday was a nice illustration of how I've become a good trader--and how far I need to go to become a great one. But taking trading to the next level means the trading ship has to leave the safe harbor. In my case, it means moving out of the comfort zone of trades where all lines up to take trades with solid, but more uncertain odds. From the weight room to the trading room, all growth occurs by pushing the limits of comfort.There are a few worthwhile takeaways from this reflection on performance:* You can't improve your performance if you don't understand your performance - I can quote my P/L, average drawdown size, hit rate, Sharpe ratio, average daily P/L volatility, etc. at the drop of a hat. The performance stats don't lie. I'm either getting better or worse, doing things right or wrong. Having detailed performance stats allows me to have a detailed understanding of performance. The trader with few trades, a good hit rate on trades, but negative P/L has a very different problem from the trader who has many trades, a poor hit rate, and the same P/L. If you don't keep score, you can't improve your score. * Qualitative information counts as well - Sometimes the best information comes from trades not taken and decisions not made. Those won't directly show up in performance stats, but may be essential to understanding our strengths and weaknesses. Friday's non-trading, for me, carries a lot of information, but won't stand out in my end-of-month or end-of-year stats.* A great deal of information can be gleaned within performance curves - When in the past 12 months have we traded best? Worst? What were the market conditions at those times? What specific things were we doing right? Wrong? Sometimes, in playing to our strengths, we create new vulnerabilities. What I've done well in trading is take the drama out. Drawdowns have been limited; the P/L has ground higher. In taking the drama out, however, I've created a new comfort zone. The shape of our performance curves invariably tell an important story.The bottom line is that coach is a verb, not a noun. It's something we must do, not a person we hire. If we are to reach our performance potential, we must be both coach and performer, studying ourselves as intensively as we study markets.Further Reading: Becoming Your Own Trading Coach
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Sunday, July 03, 2016

We can learn a great deal by studying our successes and the success of others. Here are three trading best practices that I've found to contribute to trading performance:1) Morning Preparation - Look at any successful sports team and you'll find they spend more time preparing for competition than in actual competition. On a college basketball team, a single weekend game would be preceded by drills, conditioning, and practice each week day; video review of our most recent performance to identify areas for improvement; video review of the opposing team to reveal areas of weakness; and practice of offensive and defensive strategies to maximize our advantage over the other team. By the time we walked on the court, we knew we had an edge; we had done our work; we knew our opponent; and we were prepared with our strategies. I typically wake up between 3 and 4 AM on market days and begin my day's preparation by watching how we traded in Asia, how Europe is trading, and how different markets are behaving relative to one another. I review my spreadsheets of market data and run studies to identify any possible areas of edge. By the time NY opens, I either have a clear game plan for the day's session or I don't trade. The quality of that preparation time is highly correlated with my subsequent trading performance.

2) Evening Preparation - The trading day doesn't end when the bell sounds. The trading day ends when you've reviewed performance for the day--market performance and your own--and figured out what you did well and what you'll need to improve the next day. It's also when you step back and update your understanding of market behavior. In other words, the trading day doesn't end when trading ends; it ends when you've learned from your trading. That learning in the evening consolidates overnight and becomes perspective you bring to your morning preparation. Evening preparation keeps us goal focused, keeps us working on our game. After a military maneuver, officers and troops conduct after action reviews. They plan the battle; they review the battle; they keep learning, developing, getting better. 3) Quality Time Away From Markets - Day after day, week after week, mornings and evenings: if you're trading well, it's easy to burn out. If you're going to leave everything you've got on the field by the end of the game, you're going to need to renew that energy. Just as important as the quality of your market time is the quality of your time away from markets. That includes quality time with loved ones, quality time in physical activity, and quality time immersed in meaningful personal pursuits. Quality time is time spent that gives you energy, that inspires you, that fills you with joy, a sense of meaning, energy, and love. Without positive emotional experience energizing us, our focus is diminished. That takes a toll on our pattern recognition and makes it easier for biases and impulses to color our decision making. It's not enough to relax after a market day; we need to refresh and renew.Whether in business or in trading, great outcomes come from great processes. The sad truth is that the majority of traders don't succeed because they don't do the things needed to earn success. You can have a relaxed, balanced lifestyle or you can challenge yourself, change yourself, and pursue a performance path. The greats don't push themselves to succeed; they are pulled by goals larger than themselves.Further Reading: Trading With a Solution Focus
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Saturday, July 02, 2016

There are times in life--and especially in markets--when confusion reigns. We have all the pieces but can't figure out how they fit into a puzzle. Confusion often occurs when the parts of our lives don't line up. When we see the larger picture--when all the pieces come together in a meaningful way--then we experience the opposite of confusion: clarity.We don't hear much about the topic, but one of the most important strengths in trading psychology is the ability to accept and tolerate confusion. The experienced trader recognizes that confusion is information: it is the way our minds and bodies tell us that harmony is missing--we're not seeing a bigger picture. In acknowledging and accepting confusion, we can stand back, wait for clarity, and avoid doing damage to our trading accounts. We can have a great cast of information and tools, but still be in the dark as to the plot. The experienced trader is accepting of "I don't know".When a physician is uncertain of a diagnosis--when the symptoms simply don't line up into a clear disease pattern--the last thing the physician (and patient!) wants is to jump prematurely to a conclusion and blindly try out treatments or procedures. The experienced physician will order more tests, gather more information. Confusion for the physician is a sign that more data are needed. With enough of the right information, clarity will come.The worst thing traders can do when confused is prematurely jump into trades. Traders do that because they cannot tolerate not knowing: they cannot accept uncertainty. If we're threatened with "I don't know", we'll trade without true knowledge. When market behavior is all over the place and things aren't lining up, that's our cue that, like the physician, we need to look in new places, gather more and different information. Sometimes that means sitting and letting the market gives us that new information. Confusion can be our cue that it's time to sit and gather information, to be aggressive in generating ideas rather than in risk-taking.There is another reason we can experience confusion: When we are dead wrong about markets. We assume that markets should sell off in the wake of Britain's decision to leave the EU and, lo and behold, we get strong rallies in risk assets. The experienced trader is fully open to that confusion. Rather than doubling down on assumptions by indulging in confirmation bias, the experienced trader uses the confusion to stand back and check premises. Perhaps equities and fixed income are rallying because markets care more about the prospect of global central bank easing than about the news headlines.

Overconfidence bias is deadly because it does not permit confusion and uncertainty. Confusion is our prod to learn, to expand horizons, to modify assumptions, to gather fresh information. Imagine how much better our trading results would be if we only traded when we had clarity and doubled down on idea generation when we were confused.

About Me

Author of The Psychology of Trading (Wiley, 2003), Enhancing Trader Performance (Wiley, 2006), The Daily Trading Coach (Wiley, 2009), and Trading Psychology 2.0 (Wiley, 2015) with an interest in using historical patterns in markets to find a trading edge. As a performance coach for portfolio managers and traders at financial organizations, I am also interested in performance enhancement among traders, drawing upon research from expert performers in various fields. I took a leave from blogging starting May, 2010 due to my role at a global macro hedge fund. Blogging resumed in February, 2014, along with regular posting to Twitter and StockTwits (@steenbab). I teach brief therapy as Clinical Associate Professor at SUNY Upstate in Syracuse, with a particular emphasis of solution-focused "therapies for the mentally well". Co-editor of The Art and Science of Brief Psychotherapies (American Psychiatric Press, 2012). I don't offer coaching for individual traders, but welcome questions and comments at steenbab at aol dot com.